The European Securities and Market Authority (ESMA) has reduced the maximum leverage that can be used in bitcoin trading, according to the South China Morning Post.
The new rules have reduced the maximum allowable leverage from 15x to 2x, significantly reducing traders’ potential profits (and losses). The amendment only applies to certain types of derivatives acquired through brokers, so-called CFDs. It does not apply to margin trading on crypto currency exchanges.
What is leverage?
Leverage* means borrowing money to increase the volume of your trades and thus increase potential gains and losses. The use of leverage to trade is called margin trading, and traders can either take a short position (bet that the price of the investment will fall) or a long position (bet that the price will rise).
Leverage makes Bitcoin Profit possible
Leverage makes it possible to earn much more money, but also to suffer higher losses with Bitcoin Profit. For example, with $100,000 and 15x leverage, a trader could open a $1.6 million position. If he opened a long position and the price of his investment had only risen by 1%, he would have made a profit of $16,000. Suddenly he has achieved a return of 16 percent on his capital, although the asset has only increased by 1 percent. But also vice versa: If the investment only decreases by 1 percent, he has lost 16 percent of his equity. He only has $84,000 left now.
As soon as the trader’s position falls below his minimum margin, the exchange will inevitably close his position, this process is called liquidation. A trader therefore does not have the opportunity to wait and see if the price moves in its direction again; his position is closed and his equity is lost.
Massive leverage – Amounts are regularly used in markets such as the Forex market (FOREX), where traders bet on the value of other currencies that rise or fall. Since the value of national currencies generally only increases or decreases by very small percentages, a massive leverage effect is required to make profits on the market. What really scares regulators like ESMA is the volatility of Bitcoin. Such volatility as in crypto currencies can cause immense economic damage for traders if they bet on high leverage.
Effects on the Bitcoin price
Someone who buys at 15x leverage generates much more demand and drives the price higher than someone who buys at 2x leverage. It is believed that such changes could dampen Bitcoin’s price growth during uptrending markets as margin buyers suddenly buy much less than they would otherwise.